My Illinois trust's only income is interest from a nonqualified annuity, distributed entirely to a nonresident beneficiary -- does the trust have to withhold Illinois pass-through tax on that distribution?

Plain-English summary

An Illinois trust's only income each year is interest distributed from a nonqualified annuity, and its sole beneficiary is a nonresident who receives 100% of that income on the federal Form 1041 Schedule K-1. For years, the trust had been paying Illinois's 4.95% pass-through withholding tax on the distribution on the beneficiary's behalf, but the trust's representative later questioned whether that was required, since interest-type "nonbusiness" annuity income paid to a nonresident generally isn't taxed to nonresidents by Illinois.

The Department agreed the trust doesn't have to withhold. IITA Section 709.5(a) requires a trust (like a partnership or S corporation) to withhold from a nonresident beneficiary an amount tied to that beneficiary's share of the trust's business income apportioned to Illinois, plus (for tax years ending on or after December 31, 2014) nonbusiness income allocated to Illinois under IITA Section 301. But under IITA Section 301(c)(2), nonbusiness annuity income of a nonresident isn't allocated to Illinois at all. Since the trust's only income here is nonbusiness annuity income, none of it is allocated to Illinois for this nonresident beneficiary -- so there's nothing for the trust to withhold on under Section 709.5(a).

A separate warning about fixing past over-withholding. The Department flagged that under 86 Ill. Adm. Code 100.7035(e), the trust itself cannot claim a refund or credit for any amount it over-withheld in prior years. The only way to recover an improper withholding is for the nonresident beneficiary to file a timely Illinois claim for credit or refund on their own return for the amount withheld on their behalf.

What this means for you

Trustees of a trust with a nonresident beneficiary

Before withholding under IITA Section 709.5(a), check whether the income you're distributing is actually allocated to Illinois in the beneficiary's hands. Nonbusiness income types like annuity interest allocated under IITA Section 301(c)(2) can fall outside Illinois's reach for a nonresident even though the trust itself is an Illinois trust.

Trusts that may have over-withheld in the past

Stopping withholding going forward doesn't get back money already withheld and remitted in error -- the trust can't claim that refund itself. The nonresident beneficiary has to file their own Illinois return and claim the credit or refund directly.

Accountants and tax professionals advising trusts

Distinguish carefully between business income (apportioned to Illinois under the trust's own factor) and nonbusiness income (allocated under Section 301's separate rules) before applying the Section 709.5(a) withholding calculation -- the two categories aren't withheld on the same way.

Common questions

Q: Does an Illinois trust have to withhold pass-through tax on nonbusiness annuity income distributed to a nonresident beneficiary?
A: Not if that income isn't allocated to Illinois in the first place. Under IITA Section 301(c)(2), nonbusiness annuity income of a nonresident isn't allocated to Illinois, so there's nothing to withhold on under Section 709.5(a).

Q: If a trust already withheld and paid this tax in prior years by mistake, can the trust get a refund?
A: No. Under 86 Ill. Adm. Code 100.7035(e), the trust cannot claim a refund or credit for an amount it over-withheld. Only the nonresident beneficiary can recover it, by filing a timely claim for credit or refund on their own Illinois return.

Q: What income counts toward the Section 709.5(a) withholding calculation?
A: The nonresident beneficiary's share of the trust's business income apportioned to Illinois, plus (for tax years ending on or after December 31, 2014) the beneficiary's share of nonbusiness income of the trust that's allocated to Illinois under Section 301 -- nonbusiness income that isn't allocated to Illinois doesn't count.

Citations and references

Statutes and regulations:

• 35 ILCS 5/709.5(a) (partnership, S corporation, and trust withholding on nonresident partners, shareholders, and beneficiaries)
• 35 ILCS 5/301(c)(2) (nonbusiness annuity income not allocated to Illinois for a nonresident)
• 86 Ill. Adm. Code 100.7035(e) (trust cannot claim refund/credit for a beneficiary's overwithheld amount)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2024.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2024/IT24-0012-GIL.pdf

Original ruling text

IT 24-0012-GIL 12/03/2024 PASS THRU WITHHOLDING
IITA 709.5(a) Nonbusiness Annuity Income not Subject to Withholding. (This is a GIL.)
December 3, 2024
NAME
E-MAIL ADDRESS
Dear NAME:
This letter is in response to your letter dated February 23, 2024, in which you
requested information. The Department issues two types of letter rulings. Private Letter
Rulings ("PLRs") are issued by the Department in response to specific taxpayer inquiries
concerning the application of a tax statute or rule to a particular fact situation. A PLR is
binding on the Department, but only as to the taxpayer who is the subject of the request
for ruling and only to the extent the facts recited in the PLR are correct and complete.
Persons seeking PLRs must comply with the procedures for PLRs found in the
Department's regulations at 2 Ill. Adm. Code 1200.110. The purpose of a General
Information Letter ("GIL") is to direct taxpayers to Department regulations or other sources
of information regarding the topic about which they have inquired. A GIL is not a
statement of Department policy and is not binding on the Department. See 2 Ill. Adm.
Code 1200.120. You may access our website at www.tax.illinois.gov to review
regulations, letter rulings and other types of information relevant to your inquiry.
The nature of your inquiry and the information you have provided require that we
respond with a GIL. In your letter you have stated and made inquiry as follows:
Good morning. I was referred to you for some clarity regarding the non resident
beneficiary of a trust's Form 1041. The only income the trust has every year is a
distribution of interest income from a NON QUALIFIED annuity. An Illinois trust is
the owner of the annuity. The annuity's annuitant is the NON RESIDENT 100%
beneficiary on the federal Form 1041 Schedule K-1. In past years, the trust has
been paying IL the 4.95% pass thru tax on behalf of the non resident. It has come
to light that we might be doing this wrong and that interest income to non residents
for "non business" annuity income is not taxed to non residents. My question is,
"Should the trust pay IL pass through withholding on behalf of the non resident?"
Thanks for your time. I appreciate it.
DEPARTMENT'S RESPONSE:
IITA Section 709.S(a) imposes a withholding obligation on partnerships, Subchapter
S corporations, and trusts. The section provides, in part, as follows:
For each taxable year ending on or after December 31, 2008, every partnership
(other than a publicly traded partnership under Section 7704 of the Internal
Revenue Code or

NAME
Page2
December 3, 2024
investment partnership), Subchapter S corporation, and trust must withhold from
each nonresident partner, shareholder, or beneficiary ... an amount equal to the
sum of (i) the share of business income of the partnership, Subchapter S
corporation, or trust apportionable to Illinois plus (ii) for taxable years ending on or
after December 31, 2014, the share of nonbusiness income of the partnership,
Subchapter S corporation, or trust allocated to Illinois under Section 303 of this Act
(other than an amount allocated to the commercial domicile of the taxpayer under
Section 303 of this Act) that is distributable to that partner, shareholder, or
beneficiary under Section 702 and 704 and Subchapter S of the Internal Revenue
Code, whether or not distributed, (iii) multiplied by the applicable rates of tax for that
partner, shareholder, or beneficiary under subsections (a) through (d) of Section
201 of this Act, and (iv) net of the share of any credit under Article 2 of this Act that
is distributable by the partnership, Subchapter S corporation, or trust and allowable
against the tax liability of that partner, shareholder, or beneficiary for a taxable year
ending on or after December 31, 2014.
Your letter indicates that the trust's only source of income is an annuity, and that this
income is nonbusiness income. Under IITA Section 30l(c)(2), in the case of a nonresident,
income from an annuity which is nonbusiness income shall not be allocated to Illinois.
Therefore, a trust is not required under IITA Section 709.S(a) to withhold tax on such
income. Note that under Department Regulations Section 100.7035(e), the trust may not
claim a refund or credit for any overpayment of withholding due under subsection (a) with
respect to any beneficiary. Instead, in the case of any overpayment, the remedy is for the
beneficiary to file a timely claim for credit or refund for any amount withheld under
subsection (a) with respect to it.
I hope this information is helpful. If you require additional information, please visit our
website at www.tax.illinois.gov or contact the Department's Taxpayer Information Division
at (217) 782- 3336.

Very truly yours,

Brian L. Stocker
Chairman, PLR Committee (Income Tax)
BLS:rkn